Liontrust SF Corporate Bond Fund

Q3 2018 review

The Fund returned 0.5% over the second quarter, outperforming the IA Sterling Corporate Bond sector average of -0.2% and the iBoxx Sterling Corporate Index’s -0.2%*.

 

Our overweight position in credit was the main driver, as markets stopped their recent slide and corporate bonds posted positive returns over the period. Performance predominantly came from stock selection, particularly within the portfolio’s telecommunications, insurance and bank holdings, as bonds from companies such as Orange, Prudential and HSBC outperformed the wider market.

Further positives included sector allocation more broadly and our decision to hold US dollar-denominated bonds from a number of different issuers, as USD credit outperformed sterling and euro paper. Combined with the increased cost of hedging following GBP weakness, this has seen the relative value in this market compress significantly and, as a result, we have been looking to repatriate some of our dollar holdings back into sterling, where we see better valuations at current levels.

Despite a flight to safety in August as concerns mounted over emerging markets, European politics and US-China tensions, the portfolio also benefitted from its underweight interest rate risk position as government bond yields in the UK, US and German markets all rose markedly over the quarter.

Trade war concerns have continued to dominate sentiment, with rising tensions between the US and China and the deal to overhaul NAFTA (the North American Free Trade Agreement) doing little to ease things.

Despite this backdrop however, the US economy continues to demonstrate strong positive momentum and  such robust fundamentals led the Federal Reserve to raise interest rates by a further 25 basis points at its September meeting, the third hike this year. With the decision very much expected, markets focused more on the accompanying commentary, which saw monetary policy no longer described as accommodative.

As equities fell towards the end of the period, President Trump continued his increasingly frequent attacks on the Fed, calling the central bank ‘out of control’ and ‘far too stringent’ and markets will watch this relationship carefully over the coming months. If the Trump administration does go forward with another round of tariffs and China retaliates, it could signal the beginning of a tit-for-tat escalation cycle that would be much more destructive for global growth. Commentators continue to say both sides will stop short of anything that causes too much damage and yet the sabre-rattling continues.

While US markets surged ahead for much of the period, emerging markets had a tougher time, largely caused by dollar strength and the situation in Turkey and Argentina. Turkey’s worsening relations with the US sparked a sharp selloff and exposed weaknesses such as large external debt and inflation, hidden from view by widespread liquidity in recent years.

Fears about contagion risk damaged emerging markets as a whole and while we believe that particular situation looks to be contained, Italy is another matter. Concerns surrounding the country’s political developments came to the fore in September, as the government announced proposals for a deficit of 2.4%, above European Commission guidelines. This looks set to collide with the EU’s Stability and Growth Pact and set up a showdown with Brussels, which can only increase overall volatility.

As for the UK, Brexit continues to dominate and the apparent impasse in both UK domestic politics and negotiations with the EU means the probability of a no deal has started to increase. Government bond yields were driven up by political uncertainty and trade concerns, and sterling fell over the quarter.

Meanwhile, we finally saw a long-awaited interest rate rise from the Bank of England at the start of August. With so much focus on the rise that never was back in May, the significance of this actual hike perhaps went under the radar a little. After all, it was only the second rise in a decade and takes the level back to the highest since March 2009.

Supported by such strong data, US 10-year treasury yields rose 20bps to close the period at 3.06%, close to the highest year to date level (3.11%). In the UK, 10-year gilt yields rose 15bps, while in Germany robust underlying economic fundamentals saw 10-year bund yields rise 17bps to 0.47%, despite ongoing concerns regarding Italian politics.

There was moderate portfolio activity against this backdrop. We took advantage of new issuance, which picked up in September following the summer lull – and also in anticipation of the end of the European Central Bank’s (ECB) quantitative easing program – and has been well absorbed by the market. We added new issues from Vodafone, Prudential and Investec, switching out of existing holdings to capture the attractive relative value on offer.

We also initiated a position in BNP Paribas, one of the highest rated banks in Europe. The company benefits from a retail focus as well as strong product and geographic diversification, with exposure to investment banking lower over recent years. Capital has improved significantly over the last two years, along with better transparency and a strong commitment to manage capital well above regulatory minimum levels. Due to its strong management and exposure to our Increasing financial resilience theme, BNP Paribas also scores highly from a sustainability perspective.

Elsewhere, we continue to see opportunities to capture relative value following the spread widening over recent quarters. One such opportunity has been to move further out on the credit curve, switching into longer-dated assets following a steepening in this section of the curve. As investors seek shorter duration assets, these longer-dated bonds have underperformed and there is relative value on offer: examples include switches within Legal and General and Aviva bonds.

Looking to the rest of the year and beyond, prevailing market conditions continue to reinforce our outlook from previous quarters, with economic data and corporate earnings trends remaining supportive for credit.

Our core sector preferences within insurance and telecoms, supported by attractive valuations and higher credit quality, remain unchanged. Against this we continue to reduce our exposure to the consumer sector, as spending patterns weigh on the outlook for this highly competitive area. We cut our position in Hammerson, a predominantly UK-focused property company that develops and manages shopping centres, retail parks, and office, and reinvested the proceeds into a new issue from Aroundtown, a European-focused real estate company with greater levels of residential property exposure.

We also maintain underweights to industrials, oil and gas and utilities, due to our SRI analysis coupled with an unfavourable risk/reward profile.

While our view on government bonds remains unchanged and we continue to believe yields will rise, geopolitical uncertainties in the US, as well as ongoing Brexit negotiations in the UK, have lessened our conviction regarding the direction of yields over the short term. As such, we have reduced our short interest rate risk position to one year versus the benchmark, solely expressed through the German market.

Prior to this, the position had remained unchanged over the quarter, consistently 1.5 years short relative to the benchmark split equally across the UK, US, and German markets and, as ever, we continue to actively manage the allocation between markets where we see value opportunities.

Discrete years' performance* (%), to previous quarter-end:

 

 

Sep-18

Sep-17

Sep-16

Sep-15

Sep-14

Liontrust Sustainable Future Corporate
Bond 2 Inc

0.4

2.8

13.2

3.2

7.1

iBoxx Sterling Corporate

0.0

0.3

15.9

3.9

7.9

IA Sterling Corporate Bond

0.1

0.6

12.2

2.8

6.4

Quartile

2

1

2

2

2

 

*Source: Financial Express, as at 30.09.18, primary share class, total return, net of fees and income reinvested.


For a comprehensive list of common financial words and terms, see our glossary here.

 

Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The majority of the Liontrust Sustainable Future Funds have holdings which are denominated in currencies other than Sterling and may be affected by movements in exchange rates. Some of these funds invest in emerging markets which may involve a higher element of risk due to less well regulated markets and political and economic instability. Consequently the value of an investment may rise or fall in line with the exchange rates. Liontrust UK Ethical Fund, Liontrust SF European Growth Fund and Liontrust SF UK Growth Fund invest geographically in a narrow range and has a concentrated portfolio of securities, there is an increased risk of volatility which may result in frequent rises and falls in the Fund’s share price. Liontrust SF Managed Fund, Liontrust SF Corporate Bond Fund, Liontrust SF Cautious Managed Fund, Liontrust SF Defensive Managed Fund and Liontrust Monthly Income Bond Fund invest in bonds and other fixed-interest securities - fluctuations in interest rates are likely to affect the value of these financial instruments. If long-term interest rates rise, the value of your shares is likely to fall. If you need to access your money quickly it is possible that, in difficult market conditions, it could be hard to sell holdings in corporate bond funds. This is because there is low trading activity in the markets for many of the bonds held by these funds. Mentioned above five funds can also invest in derivatives. Derivatives are used to protect against currencies, credit and interests rates move or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions.

Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Monday, October 29, 2018, 11:17 AM